Arbitrum (ARB): Analysis of the L2 Ethereum leader

What you need to know 🐳

Arbitrum is the leader in decentralised finance on Layer 2.

This position attracts many users and new applications, creating a form of virtuous circle.

Arbitrum is facing increasing competition, particularly Base, which is largely supported by Coinbase.

The project is gradually decentralising and preparing a number of ambitious updates.

General introduction 🧬

Arbitrum is a rollup of Ethereum launched at the end of August 2021.

It is therefore one of the first rollups.

A rollup is a type of layer 2 that, in its final version, fully inherits the security of its layer 1, while allowing transaction throughput to be increased and costs to be drastically reduced.

Arbitrum is currently the leading layer 2 in terms of locked value and activity. It is heavily influenced by decentralised finance (DeFi) as most of the DeFi applications in the Ethereum ecosystem are also deployed on Arbitrum, especially as Arbitrum has many applications of its own.

In March 2023, Arbitrum performed an airdrop of its ARB token to the first users of its network.

Even after the airdrop, activity on the network continued to increase, indicating a truly attractive ecosystem, not overrun by mercenary users.

Financing 💰

Offchain Labs, the US company developing Arbitrum, was founded in 2018 and has raised a total of $123.7m.

It raised $3.7 million in a seed round on 3 April 2019 from Pantera Capital and Compound VC.

In 2021, they raised $20 million in a Series A round and $100 million in a Series B round. These were completed with participation from Lightspeed Ventures, Pantera Capital and Polychain Capital.

Thus, the project has received funding from most of the leading funds in the ecosystem.

Team 👾

Most of the team is based in the US.

Steven Goldfeder is the CEO of Offchain Labs. Prior to that, he was working on his PhD in computer science at Princeton University while completing engineering internships at Microsoft and Google.

Harry Kalodner is the CTO of Offchain Labs. He too obtained his PhD in computer science at Princeton University and worked in parallel as an engineer at Apple.

Ed Felten is the scientific director of Offchain Labs. He has been a professor of computer science at Princeton University since 1993 and has also served as Deputy Chief Technology Officer at the White House.

How it works ⚙️

Transactions in a rollup are executed outside the Ethereum network to bypass its limitations, allowing for higher throughput and lower costs. The data from these transactions is then compressed and published on Ethereum.

An "optimistic" layer 2, such as Arbitrum, assumes by default that all transactions performed on its network are correct, without seeking to prove their validity.

However, there is a seven-day period during which proof of fraud can be submitted to cancel a dishonest transaction. Therefore, it is necessary to wait until the end of this period to consider a transaction officially finalised.

It should be noted that this system is not yet fully operational on Arbitrum. Currently, only a limited number of players can submit proof of fraud, but the ultimate goal is to allow everyone to do so.

Each rollup has a sequencer that orders, executes and publishes transactions on Ethereum. The sequencer collects all transaction fees paid by users and uses a portion to cover Ethereum's expenses.

Thus, the fees collected by the sequencer exceed its expenses, allowing Arbitrum to generate profits from activity on its network.

Unlike most other layer 2s, the profits generated by the Arbitrum network are sent to the DAO treasury. Currently, there is $44.5 million in ETH in the treasury.

The ARB token 🪙

There are a total of 10 billion ARBs, of which 2.9 billion are in circulation.

At present, the ARB is solely a governance token.

ARB holders vote for proposals related to Arbitrum updates and DAO cash management. It is also possible to delegate ARBs to representatives.

Like most layer 2 tokens, ARBs do not capture the value generated by the network. However, this could change in the coming months or years when the sequencer is decentralised.

The distribution of tokens from the Offchain Labs team (27% of ARBs) and private investors (17.5% of ARBs) began in March 2024, creating a sharp increase in the amount of tokens in circulation. This distribution will continue until March 2027.

The DAO owns 3.16 billion ARBs, or around 31% of tokens, which is currently equivalent to $2.78 billion. In addition, there is $44.5 million in ETH, which represents the profits generated by the network.

The DAO funds operations to promote on-chain activity, including offering ARBs to selected protocols on the Arbitrum network.

Recently, the DAO voted to launch the Gaming Catalyst Program, a programme that aims to invest 225 million ARBs to boost the gaming sector on the network. This vote was strongly criticised by some in the community, as it represents a considerable outlay to develop a sector that has seen many failures to date.

Unlike most other layer 2s, Arbitrum's governance is carried out on-chain. This means that a decision voted by the DAO does not need to be validated and implemented by an external entity.

There is a 12-member Security Council, divided into two groups of 6 members. Elections are held every six months, where members of one of the two groups are replaced by a vote of TRP holders. In this way, each group remains in place for one year. Here is the current list.

The Security Council can update the protocol without delay in an emergency if 9 of the 12 members approve this decision.

Thus, Arbitrum currently stands out as one of the layers 2 with the most decentralised governance, if not the most advanced in this area. Of course, Offchain Labs still plays a very important role in Arbitrum's development.

Roadmap and the road to decentralisation  🏁

Arbitrum is collaborating with Espresso, a shared sequencing marketplace secured by Eigen Layer, to decentralise its sequencer. This improves its resistance to censorship while preserving the low latency and high transaction throughput https://research.arbitrum.io/t/the-power-of-faster-blocks/9609.

Arbitrum is also working on implementing BoLD. This will allow anyone to submit evidence of fraud.

In addition, Arbitrum is developing Stylus, which will allow the network to support different programming languages such as Rust, C, C++ in addition to Solidity. This gives application developers more choice, especially as these languages could be up to 10 times more powerful.

Ecosystem 💪

Arbitrum's success is mainly attributed to the development of decentralised finance, in particular derivatives trading.

GMX, a derivatives DEX launched on Arbitrum in 2021, has largely contributed to the development of DeFi. It offered considerable resilience during the bear market of 2022 and 2023.

Vertex is also a derivatives DEX with significant activity.

Pendle (read our analysis), a protocol that enables the trading of crypto returns, also plays a crucial role in DeFi on Arbitrum.

AAVE is the most important lending protocol on Arbitrum.

Offchain Labs has also developed Arbitrum Nova, another layer 2 whose architecture prioritises performance over security, with the aim of developing gaming-related applications.

Finally, Arbitrum includes several layer 3s that focus primarily on NFT and gaming, such as MXC, Sanko and Rarichain. Most of these projects are still very new, so it is advisable to do your homework before investing funds in them.

Competition ⚔️

Arbitrum, Optimism and Polygon have developed development tools which, coupled with rollups-as-a-service providers such as Conduit, have greatly facilitated the launch of layers 2 and 3.

The proliferation of these blockchains designed to lighten Ethereum is creating increasingly fierce competition. There are fairly few fundamental differences between them, apart from the applications they have and the liquidity deposited on them.

Arbitrum's historical rival is Optimism. For a long time, Optimism had not implemented the proofs of fraud that are supposed to secure its channel, but this has recently changed as the system is finally in place and any player can submit them.

The two seem to be moving towards different strategies. Indeed, Arbitrum is not really pushing the idea of a multichain ecosystem, while Optimism is insisting on its Superchain, greatly helped by the participation of Base, which has had very strong traction in recent months. Base has even overtaken Optimism in terms of locked value (TVL).

Base is enjoying very strong exposure thanks to Coinbase. The network is attracting more and more users and applications, and strong activity around memecoins is developing in parallel. Base is currently the layer 2 with the most transactions per second.

Arbitrum comes second in terms of transactions per second, but is by far the layer 2 with the lowest latency, which is a very important feature in DeFi.

Blast opts for a more aggressive strategy with a points-based airdrop system, native yields on most of the cryptos on the chain and an ecosystem of apps that share this image.

Polygon (read our analysis) and zkSync (read our analysis) seem to be heading in similar directions: creating a layer 2 ecosystem based on ZK technology with a single bridge coupled with a proof aggregation system to create greatly improved interoperability and solve the fragmentation of liquidity between channels. This vision looks more promising in the long term, but takes time to be fully deployed.

Below is a comparison of the evolution of locked-in value on these projects.

Regulation ⚖️

The European framework for crypto-assets does not pose any particular problems for Arbitrum. However, there are still uncertainties in the US, as the project has raised funds in exchange for its token from US venture capital funds.

This could requalify the project as an illegal issuance of financial securities, especially as its start-up, Offchain Labs, still plays a significant role in development.

To avoid potential prosecution in the US, Arbitrum would do well to accelerate its decentralisation.

Market analysis by Chadi El Adnani, Head of Content & Research at SUN ZU Lab 📈

The price of ARB has fallen by 40% since the start of the year, currently trading at around $0.8. Daily volumes have also halved from levels in the first three months of the year, rarely exceeding $200 million since April.

Comparatively, OP (Optimism) has fallen 52% since the start of the year, while BTC and ETH have risen 60% over the same period. The two Layer 2 leaders did not benefit from the increase linked to the announcements of the validation of ETH spot ETFs at the end of May. However, TVL on Arbitrum is up 25% year to date, according to DefiLlama data.

It is important to note that Arbitrum floated the equivalent of $2.32 billion in ARB tokens on 16 March 2024, and the market capitalisation rose by the same amount before almost disappearing entirely since. At the time, the community was concerned about the impact this massive distribution could have on the price of ARB. Indeed, the 1.1 billion tokens represented 76% of the supply in circulation.

Where can you buy the ARB token? 🛒

The ARB token is available on most of the major regulated centralised exchange platforms in Europe, such as Binance or Coinbase. It is also available on decentralised exchange protocols, such as Uniswap.

The Big Whale's opinion 🐳

Arbitrum is one of the pioneers among layers 2 (layers 2) and remains the leader in terms of locked value and innovations in DeFi. This position benefits Arbitrum, which finds itself in a virtuous circle attracting ever more cash and applications.

Currently, the optimistic layers 2 model is the most attractive and is likely to remain so for some time. However, rapid advances in zero-knowledge technology will eventually reverse this trend, enabling greater interoperability between layers 2.

In time, Arbitrum will need to assess its ability to migrate to ZK technology when it becomes more mature.

Until now, layer 2 governance tokens have performed poorly as they have little real utility and have been launched at very high valuations. In addition, private investor tokens are gradually unlocking, adding significant selling pressure.

Gradually, Ethereum's Layer 2s are making progress towards decentralisation and attracting ever more liquidity. At the same time, their tokens will gradually gain in usefulness and sooner or later capture some of the value generated by the network.

It is therefore not impossible that the dynamics of layer 2 tokens will eventually reverse, which would benefit leading layer 2 tokens such as ARB.